What Just Happened?

The National Venture Capital Association recently released data on 1Q14 investment activity, which always makes for an interesting read – at least on long plane rides. Point of fact, this past quarter was exceptional in many ways – and arguably somewhat unexpected. The headlines read that $9.5 billion was invested in 951 companies, an amount we have not seen since the fateful quarter of 2Q01. But it is what is beneath the headlines, buried in the reams of data, which paints a more nuanced picture.

Undoubtedly the level of investment over the first 90 days of 2014 was unprecedented. In 4Q13 and 1Q13 the amounts were $8.4 billion in 1,112 companies and $6.0 billion in 916 companies, respectively. Clearly the stepped up investment pace throughout 2013 extended into 2014 – and tracked the increased liquidity VC’s witnessed along the way. Given the marked public stock market volatility which set in this past February it would not be surprising to see activity tempered over the next few quarters, suggesting that we probably are not on an annual investment pace of ~$38 billion for 2014 (4 x $9.5 billion); for context annual investment activity from 2011 – 2013 averaged ~$28 billion.

Overall certain important themes are emerging in 1Q14 data – VC’s are clearly investing in later stage companies, VC’s are investing in businesses that have meaningfully less technology and development risk, and round sizes have spiked, most notably by “mega rounds” of hundreds of millions of dollars – which probably skews the data somewhat.

So what jumped out at me?

  • Dramatic decline in Seed investing: only $125 million was invested in 41 seeds (average size $3.0 million) in 1Q14 as compared to $347 million in 69 companies (average size $5.0 million) in the prior quarter, which is a decrease of 64%. The advent of the micro-VC and “super angel” investor from a few years ago may be running its course.
  • Where did the Seeds go: Early round financings were $2.9 billion (451 companies, average size $6.4 million) of the activity which is a meaningful step up from 1Q13 of $1.6 billion (420 companies, average size $3.7 million). Not surprisingly many of the Seeds from prior periods have graduated onto the next phase of growth.
  • Expansion stage financings really spiked up: in 1Q14 $3.9 billion was invested in 274 companies (average size $14.3 million) which was over 40% of all investment activity for the quarter, as compared to $2.1 billion in 239 companies (average size $8.6 million) in 1Q13. Quite clearly VC’s are doubling down and supporting those Seeds which appear to be breaking out with larger rounds.
  • The Software category sucked the air out of the room: Software was 42% of all financing activity and by far and away the largest of the 17 categories tracked. In 1Q14 $4.0 billion was invested in 414 Software companies (average size $9.7 million) as compared to $2.3 billion in 361 companies in 1Q13. Arguably this activity came at the expense of other categories such as Telecom, Semiconductor, Networking and Equipment, Electronics which barely registered this past quarter (only $20 million was invested in Networking and Equipment for instance).
  • Services investing surged in 1Q14: all categories of Services (Business, IT, Financial, Consumer) more than doubled from 1Q13 and was $1.7 billion in 126 companies (average size $13.4 million). This is somewhat surprising given the historic VC aversion to services business models as they “don’t scale” and have lower gross margins. Are VC’s investing in safer companies? Clearly they have all but avoided capital intensive hardware businesses.
  • Healthcare held its own: in 1Q14 $1.7 billion was invested in 182 companies as compared to $1.5 billion in 182 companies and $1.9 billion in 252 companies in 1Q13 and 4Q13, respectively. Overall, though, healthcare (Biotech, Medical Devices, Healthcare Services) captured only 15% of all dollars invested.
  • Which category was the dark horse: over $250 million was invested in Retailing this past quarter as compared to $17 million in 1Q13!

The shuffling between stage of investing and industry categories is always illuminating. VC’s seem to be investing later to get closer to liquidity, perhaps to bolster their own fundraising stories as they set out to raise the new funds, but to also exploit the robust public capital markets. Arguably the rotation among industry categories reflects prior investment performance by category. Hardware centric businesses and those with long product development cycles have chronically disappointed investors; where would Biotech be right now were it not for the “biotech bubble” we witnessed over the past six months.

The other barometer of risk taking is “First Time Financings” which tracks companies receiving venture capital for the first time; some interesting developments jump out of those data:

  • First Time Financings in 1Q14 totaled $1.2 billion or 13% of all investment activity, which compares (poorly) to 21% and 19% in 1Q13 and 4Q14, respectively.
  • Early stage First Time Financings was $830 million of that activity, which was down slightly from $887 million in 1Q14, although Expansion stage showed a more marked decline to $135 million from $227 million in the prior quarter.

And I always get a kick out of some of the other data buried in the report…

  • 23 states had 3 or fewer venture investments in 1Q14. In fact 7 states had zero.
  • California captured $5.5 billion of the $9.5 billion invested which was up substantially as a percent of total dollars invested from 1Q13: 58% now as compared to 48% from a year ago. Further concentration of activity – although for those of us not in California it is important to note it is a huge state!
  • Hawaii, on the other hand, had 2 venture-backed investments which raised in total $271,000! How cute.
  • The Top 10 venture investment rounds in 1Q14 were at least $100 million in size (are those venture deals, really?) with Dropbox raising $325 million registering as the largest. And there were no healthcare companies on this list. These mega-rounds reflect funds with either too much capital or a strategy to anoint winners and thereby chilling any competitive companies being launched – but will they drive great returns – stay tuned.


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2 responses to “What Just Happened?

  1. Michael, great summary of the dynamics in the industry right now. My observation is that the pressure to put capital to work in large chunks has almost split the late stage business into two categories: regular late stage growth deals and cross over mega deals (Dropbox being the poster child). When you see PE funds coming “down market” into these mega deals, you see valuations and leverage balloon. The former impacts VC fund returns and the latter can impact the future of the company. When the cycle turns, it will be interesting to see how these deals add or detract to overall returns.

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